Trade policy uncertainty could bolster U.S. defensive stock sectors

NEW YORK (Reuters) - As the United States ramps up import tariffs and long-date U.S Treasury debt yields remain low, stocks in so-called defensive sectors may have room to run higher in price, even though expectations for the currently quarterly earnings seasons are high.

Traders work on the floor of the New York Stock Exchange (NYSE) in New York, U.S., July 13, 2018. REUTERS/Brendan McDermid

Stocks in defensive sectors, which generally pay steady dividends and have steady earnings, languished for the first months of 2018. Utilities, real estate, telecommunications and consumer staples all saw their stocks fall into early June even as the U.S. benchmark S&P 500 index rose more than 4 percent.

But over the past 30 days, two of those sectors have led the S&P 500 in percentage gains as geopolitical risk has risen.

By contrast, shares in several cyclical sectors, which tend to rise as the economy grows and are often favored by investors in the late stage of a bull market, have dropped over the same period. Industrials have slumped 3.9 percent, while materials have slid 3.6 percent and financials have fallen 2.7 percent.

Several conditions have supported a rotation into defensive stocks, investors said.

They tend to perform better when interest rates are low, and they have risen as yields on the 10-year Treasury note have retreated from the 3.0 percent mark since early June.

A burgeoning U.S. trade war with China and the European Union has also led investors to seek stability. On Tuesday, the White House proposed 10 percent tariffs on an additional $200 billion worth of Chinese goods.

Seven out of 25 of the S&P 500 consumer staples companies have reported so far, and of those, 86 percent have beaten analyst estimates for revenue and profit. Generally, staples and other defensive areas lag the other S&P 500 sectors in revenue and earnings growth.

Some market watchers have begun to recommend portfolio adjustments in anticipation of a downturn in U.S. stocks.

On Monday, Morgan Stanley’s U.S. equities strategists upgraded consumer staples and telecom stocks to an “equal weight” rating, after raising utilities to “overweight” in June. They downgraded the technology sector, which accounts for more than a quarter of the weight of the S&P 500, to “underweight.”

“We expect the path to be bumpy for the next few months,” said Keith Lerner, chief market strategist at SunTrust Advisory Services in Atlanta, which in May added exposure to real estate stocks in one of its portfolios. “Having some dividend strategies is likely to be a nice ballast.”

Few investors believe the end of the bull market is imminent though.

Some said the gains in defensive sectors are bound to be short-lived as strong corporate earnings and continued economic strength boost market sentiment. Others believe recent tensions between the U.S. and China over trade policy will be resolved by the autumn as the U.S. midterm Congressional elections approach.

“We have solid earnings growth, and we have an economy that continues to march down the path of acceleration,” said Emily Roland, head of capital markets research at John Hancock Investments in Boston. “Those (defensive) sectors are not attractive to us.”

Even so, defensive sectors could draw investors’ attention in the next few months if stockmarkets remain choppy. As they have languished in the past few years, stocks in those sectors could offer value, especially if the companies raise dividends, said Kate Warne, investment strategist at Edward Jones in St. Louis.

The improving performance of stocks in defensive sectors may ultimately be beneficial for the market, some investors said.

The lion’s share of growth in the S&P 500 index has come from technology and consumer discretionary stocks: most notably, Facebook Inc, Amazon.com Inc, Netflix Inc and Google parent company Alphabet Inc, collectively known as FANG.

If other sectors can contribute more to the index’s gains, investors may have more confidence in diversifying their portfolios.

“With a very narrow market like you’ve had most of this year, it’s great for stock pickers, but it’s hard for indexes to make money,” said Robert Phipps, a director at Per Sterling Capital Management in Austin, Texas. “What you’re seeing is a broadening out of the market, which is extraordinarily helpful.”